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Making America Great Again (at least for Trump’s friends)


Amy Pereira

By

May 20th, 2017


What Donald Trump plans to do to banking regulation in the US, and why it could cause another financial crisis.

This article first appeared in Short Supply 2017 – check out the full magazine via the Short Supply tab at the top of this page!


Donald Trump won the presidential campaign off the back of the ‘forgotten man’. He promised to make America great again, courting the support of a resentful working class who had been promised the American Dream, yet have failed to accomplish it. He accused Hilary Clinton of “meeting in secret with international banks to plot the destruction of US sovereignty” [1] and framed the Obama administration as being controlled by a handful of power institutions rigging the system.

Upon his election however, Trump has embarked upon a policy trajectory that’s a complete reversal of both his campaign rhetoric and the course of American policymaking since the Global Financial Crisis (GFC).

The Obama administration legislated to restrain banks from engaging in the excessive risk-taking and leveraging that caused the GFC. Trump however appears to be throwing it out the window, championing deregulation, free market capitalism and high-risk lending.

This is good for Wall Street, but not so good for the middle class he so avidly campaigned for in the election. Trump’s behaviour is often impulsive, and so the backflip isn’t necessarily surprising, but it is concerning.

 

Bank regulation in the US: the Dodd-Frank Act

In the aftermath of the GFC, there was broad consensus among economists and regulators that deregulation of the banking system in the US had gone too far. The basic premise of the Obama administration, and the Federal Reserve, was that a responsible government has an obligation to regulate the system in order to avoid a similar crisis in the future. [2]

The Obama administration sought to reduce exposure to risky financial products and prevent the need for billions of dollars in bailouts as in the GFC. The result was the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), signed into federal law in July 2010.

The Act is named after former Democrats Senator Chris Dodd and Representative Barney Frank, who were the architects of the legislation and sponsors of the bill.

 

How does Dodd-Frank regulate banks?

Dodd-Frank aims to combat the ‘too-big-to-fail’ problem, in which financial institutions become so large and so interconnected that their failure would have disastrous consequences for the greater economic system. [3]

Dodd-Frank increases the amount of reserves that must be held by banks. Global systematically important banks, or G-SIBs, such as Citigroup, JPMorgan Chase and Bank of America, must hold additional capital known as the G-SIB surcharge. Such banks are required to keep as much as 3% of their shareholders’ equity in cash or low-yielding but highly liquid securities. [4] By forcing banks to hold greater reserves, and liquid securities, Dodd-Frank ensures that banks have a cushion to absorb loan losses in future downturns. At the height of the pre-GFC bubble, some banks were leveraged at a debt to capital ratio of 33:1, and so quickly become insolvent when a relatively small number of mortgages defaulted.

Dodd-Frank also requires banks with assets of $50 billion or more to have a bankruptcy plan that guides their dissolution and liquidation without government bailouts, should they collapse. [5] This aims to prevent the government from having to bail out banks, as it did in 2008 and 2009, costing taxpayers hundreds of billions of dollars.

Banks are also prohibited from engaging in highly speculative forms of investments, called proprietary trading. [6] Investing in owning or sponsoring hedge funds and private equity funds with both the banks’ money or customer deposits is not allowed.

Dodd-Frank establishes a number of regulatory bodies such as the Financial Stability Oversight Council, and the Consumer Financial Protection Bureau, which oversee macroprudential risk, and consumer protection respectively.

Credit rating agencies are also regulated under the Act, and must submit their rating systems for review to the Office of Credit Rating at the Securities and Exchange Commission. [7] Credit rating companies such as Moody’s and Standards & Poor’s were responsible for misleading investors by over-rating derivatives and mortgage backed securities.

 

The case of deregulation

Some reject regulation on an ideological basis, instead championing the free capital markets and no bailouts. Others, particularly those in the banking industry, would simply prefer that the industry not be regulated. Banks feel that they could do business more aggressively, and argue that economic growth has suffered under Dodd-Frank. [8]

Trump’s team is full of the people in the latter group. The National Economic Council Chief, Gary Cohn, was Chief Operating Officer of Goldman Sachs. The Treasury secretary, Steve Mnuchin, is a hedge fund manager who used to work for Goldman Sachs. A key adviser to Trump on Dodd-Frank is Jamie Dimon, Chief Executive of JPMorgan.

Trump’s argument that a policy of deregulation will unleash prosperity and return jobs to thousands of unemployed people, has little logic however. Unemployment in the US is already at a 10-year low, as are interest rates. [9]

 

What are Trump’s plans?

At the time of writing, Trump has only issued an executive order for a review of Dodd-Frank. The review is to be conducted by Mr Mnuchin. If by the time of publishing, recommendations have been made to completely gut Dodd-Frank, it would not be surprising.

In May, the House of Financial Services Committee voted in favour of the Financial Choice Act, which would weaken the powers of the Consumer Financial Protection Bureau, and exempt some financial institutions from capital and liquidity requirements. However, in its current form, the Financial Choice Act is unlikely to pass the Senate, where it would need support from Democrats to gather enough votes.

In comparison, there is a greater risk that Dodd-Frank will be implemented and overseen by and for the interests of the wealthy businessmen who currently advise Trump, and whose opinions Trump clearly values. [10] They are, after all, his friends. Trump explains himself “I have so many friends, with nice businesses, [who] can’t borrow money because the banks just won’t let them borrow, because the rules and regulations and Dodd-Frank.” [11]

A deregulated system, or at least a poorly supervised system, can and will generate hidden risks which will be of major consequence for years to come. Trump is possibly sowing the seeds of destruction already.

They say that fear fades with memory. A wealthy individual himself, Trump has little to fear, and so it seems, little to care about if he is in fact laying the foundations for another financial crisis.

 

Amy is a fifth year Commerce and Law student. She takes particular interest in political economy and public policy.

 

[1] Kampeas, R. (14 October, 2016). Donald Trump’s ‘international bankers’ speech leaves some uneasy. The Telegraph. Retrieved from http://www.jta.org/2016/10/14/news-opinion/politics/donald-trumps-conspiracy-theories-stir-uneasy-echoes

[2] Yglesias, M. (8 February, 2017). The return of an unfettered Wall Street. Vox. Retrieved from https://www.vox.com/policy-and-politics/2017/2/8/14521806/trump-dodd-frank-rollback

[3] Maxfield, J. (2017). The Dodd-Frank Act explained. Retrieved from https://www.usatoday.com/story/money/2017/02/03/the-doddfrank-act-explained/97454748/

[4] Ibid

[5] Ibid

[6] Ibid

[7] Ibid

[8] Yglesias, M. (8 February, 2017). The return of an unfettered Wall Street. Vox. Retrieved from https://www.vox.com/policy-and-politics/2017/2/8/14521806/trump-dodd-frank-rollback

[9] Kim, T. (3 February, 2017). Goldman’s chief economist sees Trump’s pro- growth moves outweighing any protectionist measures. CNBC. Retrieved from http://www.cnbc.com/2017/02/03/goldman-sees-trumps-pro-growth-moves-outweighing-any-protectionist-measures.html

[10] Yglesias, M. (8 February, 2017). The return of an unfettered Wall Street. Vox. Retrieved from https://www.vox.com/policy-and-politics/2017/2/8/14521806/trump-dodd-frank-rollback

[11] Ibid

Image: ‘Donald Trump’ by Gage Skidmore, https://flic.kr/p/LWto54. Licence at https://creativecommons.org/licenses/by-sa/2.0.

The views expressed within this article are those of the author and do not represent the views of the ESSA Committee or the Society's sponsors. Use of any content from this article should clearly attribute the work to the author and not to ESSA or its sponsors.

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